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en-usTechdirt. Stories filed under "valuations"https://ii.techdirt.com/s/t/i/td-88x31.gifhttps://www.techdirt.com/Fri, 15 Mar 2013 16:01:00 PDTBankrupt 1990s Internet Toy Company Still Thinks It Was UndervaluedDealbreakerhttps://www.techdirt.com/articles/20130314/17002022329/bankrupt-1990s-internet-toy-company-still-thinks-it-was-undervalued.shtml
https://www.techdirt.com/articles/20130314/17002022329/bankrupt-1990s-internet-toy-company-still-thinks-it-was-undervalued.shtmlCross-posted from
To get a sense of how old the Goldman Sachs IPO lawsuit-and-maybe-scandal that Joe Nocera and Felix Salmon wrote about this weekend is, consider this: the alleged victim was a company named eToys. With the “e,” and the “Toys,” and the weird capitalization. Also Henry Blodget was the analyst who covered them at Merrill. Different times!

Nocera gives the basic facts and there’s something a little off about them:

The eToys initial public offering [in May 1999] raised $164 million [at $20/share], a nice chunk of change for a two-year-old company. But it wasn’t even close to the $600 million-plus the company could have raised if the offering price had more realistically reflected the intense demand for eToys shares. The firm that underwrote the I.P.O. — and effectively set the $20 price — was Goldman Sachs.

After the Internet bubble burst — and eToys, starved for cash, went out of business [in March 2001] — lawyers representing eToys’ creditors’ committee sued Goldman Sachs over that I.P.O.

The theory of the lawsuit is that Goldman screwed eToys on behalf of investors, pricing the IPO at $20 per share, rather than the $78 justified by demand, as evidenced by the fact that the stock briefly traded at $78 on the first day. An alternative theory is that Goldman screwed investors on behalf of eToys, pricing the IPO at $20 per share, rather than the $0 justified by fundamental value, as evidenced by the fact that the company went out of business 22 months after the IPO. Also it was called eToys, come on.

Are you surprised that investors sued Goldman too? Of course not, right? After all, they lost a lot more money. The surprising thing to me, as a wholly post-internet-bubble capital marketeer, is that the investor suit is not so much about “your prospectus said you would deliver childhood dreams and you instead delivered full-grown bankruptcy” as it is about the laddering and commission kickbacks that Nocera and Salmon describe. (Though: imagine the shareholder lawsuits if it had priced at $75.) Here’s Nocera:

Goldman carefully calculated the first-day gains reaped by its investment clients. After compiling the numbers in something it called a trade-up report, the Goldman sales force would call on clients, show them how much they had made from Goldman’s I.P.O.’s and demand that they reward Goldman with increased business. It was not unusual for Goldman sales representatives to ask that 30 to 50 percent of the first-day profits be returned to Goldman via commissions, according to depositions given in the case.

Let’s stipulate that some of the explicit quid pro quo stuff is bad, as are allegations that some clients conducted wash trades to kick Goldman sufficient commissions. Bad enough that various banks settled various lawsuits over dotcom-era hot-IPO-allocation practices, including Goldman settling with the SEC in 2005 over related “laddering” charges. The dotcom era is mostly in the past and so are those sorts of practices.

Others are not. Nocera cites an email from Bob Steel – then GS head of ECM, now Bob Steel – to Tim Ferguson at Putnam, saying in part “we should be rewarded with additional secondary business for offering access to capital markets product.” This email strikes me as pretty pretty standard even today. As Salmon says:

I’m sure if a determined prosecutor went hunting for similar emails today, she could probably find them. But I don’t know what the point would be. Because there’s nothing illegal about asking buy-side clients to send commission revenue your way — or even about explaining to them how much money you’ve helped them make.

True! There’s nothing illegal about telling your clients that you’re doing a good job for them.1 Is there anything scandalous? Obviously making money for investor clients by underpricing an IPO is in conflict with raising money for issuer clients by overpricing the IPO. That is the point of IPOs. There is that conflict, and the bank is there to mediate it, and the bank’s incentive to mediate is that it makes money from both sides.2

Salmon explains Goldman’s pitch to eToys:

On the page headlined “IPO Pricing Dynamics”, they explained that the IPO should be priced at a “10-15% discount to the expected fully distributed trading level” — which means not to the opening price, necessarily, but rather to the “trading value 1-3 months after the offering”. After all, this was the dot-com boom: everybody knew that IPOs were games to be played for fun and profit, and that the first-day price was a very bad price-discovery mechanism.

Right? eToys knew that it was leaving boatloads of money on the table for investors, and it knew that Pets.com and WebNonsense and the rest of its ilk before it had also left boatloads of money on the table for investors, and that that was why investors would give $164 million to a company called eToys that had – I mean, do I need to even say this? – never made a profit, and never would. That was the trade that eToys made: it let investors have an IPO pop, and in exchange they let eToys have an IPO.

The thing about this tradeoff is that it’s totally transparent. An IPO prices, and then it trades. You can look on Google Finance – back then it was probably AltaVista Finance but you know what I mean – and actually see where it’s trading. You can ask a bank for a list of their IPOs, and then see how they traded. If Bank X’s deals all left tons of money on the table and Bank Y’s didn’t, you might consider using Bank Y. Bank Y might even consider advertising this fact to you – just as Bank X is out advertising it to investor clients.

Now perhaps “totally transparent” overstates it a bit. The banks are masters of data-cutting, so they’ll focus you on the deals they want you to focus on (“joint books deals since 1998 excluding online pet product retailers”3). The “fully distributed trading level” blather is an example of that: 300% one-day pops look bad, so you focus clients elsewhere.

And investors have some advantages in their tug of war with issuers. They’re repeat players, for one thing, and they think about capital markets all day, so they have more incentive and ability to pay attention to which banks are systematically underpricing or overpricing deals. Also money: as Felix Salmon points out, Goldman likely made a lot more from investors kicking back 30-50% of their first-day eToys pop in commissions than it did on eToys paying its 7% fees. Even assuming explicit wash-trade kickbacks are gone, investors might still have the upper hand: at Goldman, for instance, 2012 equity underwriting revenues were a little under $1bn, and total investment banking advisory revenues were a little under $5bn, while equities division revenues – market making, commissions, and prime brokerage – were over $8bn.4 The more the trading side runs the place, the more its clients will tend to win out against issuers.

Nonetheless the right model is “constant tension,” not “one-sided screwing of issuers by investors.” One way to tell: if the issuers constantly got screwed, there’d be demand for things like direct auction IPOs that bypass investment banks. There is not. Issuers know that the model of banks currying favor with investors gets them better capital markets access, even if their stocks are the currency used to curry favor.

Another way to tell: if the issuers constantly got screwed, and the investors constantly made out like bandits, you’d see a lot of eToys-type lawsuits brought by issuers, and very few Facebook-type lawsuits brought by investors. That is not the case. There are more investor lawsuitsover the Facebook IPO than there are issuer lawsuits over any IPOs.5 That suggests that the issuers are doing okay.

1.Also, like: you’re the head of equity sales or whatever at a bank, and you go meet Putnam, and you ask yourself: what do I tell them about why they should give us more business? I submit to you that things like “our guys have taken you out to some great dinners,” “we reply to your Bloombergs promptly,” and “our research is nicely formatted” are all considerably less impactful than “we bring you IPOs that you make a lot of money on.” Capital markets deals really are a big part of the service that big banks offer their investor clients.

2.Thus eToys’s contention that Goldman owed it a fiduciary duty as underwriter is sort of nuts. Nocera:

As for the litigation itself, Goldman has argued that, contrary to popular belief, underwriters do not have a fiduciary duty to the companies they are underwriting. In recent years, this argument has held sway in the New York court system, although it has yet to be argued before the Court of Appeals.

What popular beliefs about underwriter fiduciary duties in IPOs do you think exist? And what could those duties be? If a bank’s duty was to maximize price on every IPO then it would screw investors over and over again and they’d get sick of it and lowball the banks’ next deals. Given that banks and issuers know more about their stock than investors, you’d end up with a market-for-lemons problem, and issuers as a class would be worse off. The point of the bank is to curry favor with investors – sometimes by leaving a little bit of money on the table for them – in order to help sell the next deal. That’s why you go to a bank: because they have a good relationship with investors. How do you think they got that relationship?

3.I once reviewed a fee run with a little footnote accurately describing it as “excluding REITs,” which would be fine (REITs are weird and many data runs exclude them), except that we were showing it to a REIT. I can’t quite remember, but I want to believe I had it changed.

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]]>never-give-up-the-.com-bubble-dreamhttps://www.techdirt.com/comment_rss.php?sid=20130314/17002022329Thu, 28 Feb 2013 20:07:00 PSTThe SEC, Like Everyone Else, Didn't Believe Citi's Financial StatementsDealbreakerhttps://www.techdirt.com/articles/20130228/15495422160/sec-like-everyone-else-didnt-believe-citis-financial-statements.shtml
https://www.techdirt.com/articles/20130228/15495422160/sec-like-everyone-else-didnt-believe-citis-financial-statements.shtmlCross-posted from
Every once in a while I almost write "I don't envy big bank CEOs," and then I consider my own finances and the mood passes. But it does seem hard, no? The job is basically that you run around all day looking at horrible messes – even in good times, there are some horrible messes somewhere, and what is a CEO for if not to look at them and make decisive noises? – and then you get on earnings calls, or go on CNBC, or sign 10Ks under penalty of perjury, and say "everything is great." I mean: you can say that some things aren't great, if it's really obvious that they're not. If you lost money, GAAPwise, go ahead and say that; everyone already knows. But for the most part, you are in the business of inspiring enough confidence in people that they continue to fund you, and if you don't persuade them that, on a forward-looking basis, things will be pretty good, then they won't be.

Also, when you're not in the business of convincing people to fund you, you're in the business of convincing people to buy what you're selling and sell what you're buying, which further constrains you from saying "what we're selling is dogshit."1

Anyway I found a certain poignancy in Citi's correspondence with the SEC over Morgan Stanley Smith Barney, which was released on Friday. Citi and Morgan Stanley had a joint venture in MSSB, and MS valued it at around $9bn, and Citi valued it at around $22bn, and at most one of them was right and, while the answer turned out to be "neither," it was much closer to MS than C. Citi was quite wrong, and since this was eventually resolved by a willing seller (Citi) selling to a willing buyer (MS) at a valuation of $13.5bn, Citi had to admit its wrongness in the form of a $4.7 billion write-down, and the stock did this:

Which is the market's way of saying: no biggie Vikram, we already knew you'd be taking the writedown, honestly we thought it'd be worse than that, we just didn't say anything because we didn't want you to feel bad, but we're glad that's cleared up now.

But the SEC doesn't get to do that, because – and this is sort of endearing – the SEC has to pretend that a company's financial statements convey meaningful information about the actual world, and so last year they sent Citi a bunch of letters to the effect of "um, really, with that MSSB valuation?" To be fair even Citi was admitting, back in its 10-K a year ago, that MSSB wasn't worth what its balance sheet said it was worth – but it said that this was a temporary impairment and so didn't need to be reflected on Citi's financials since MSSB would recover soon and anyway it's not as if Citi was looking to sell at a depressed price. Here is how the SEC responded in April:

You assert that, as of December 31, 2011, you do not plan to sell your investment in this joint venture prior to recovery of the value. Please tell us how you were able to reach this conclusion given the fact that you are currently in negotiations with Morgan Stanley to sell at least part of your equity interest in this joint venture pursuant to options held by Morgan Stanley.

We note that you have based the fair value of this equity investment on “the midpoint of the current range of estimated values.” However, you do not disclose this range, nor do you disclose how the range was estimated.

We are not in fact negotiating with Morgan Stanley about selling the rest of MSSB, and

We can't disclose our internal estimate of MSSB's value, because that would hurt us in our negotiations with Morgan Stanley about selling the rest of MSSB.

See what they did there?2 The SEC did, a few months later anyway, when the negotiations got so advanced that the SEC pushed Citi for more information about its internal valuation of the MSSB joint venture. Citi obligingly provided that valuation to the SEC, confidentially, ten days after it disclosed the write-down.

Also during these negotiations Citi's investment banking division provided a valuation of MSSB "that slightly exceeded Citi's carrying value of approximately $11 billion for that 49% interest as of June 30, 2012." So:

Citi provided a valuation of an asset to its counterparty as a negotiation tool,3

which was higher than the valuation it reflected in its publicly filed financial statements,

which was higher than its internal estimate of the correct valuation,

which was closest to the market's estimate of the correct valuation, and the ultimate valuation at which Citi sold the asset.

So Citi "knew" that its financials, and the valuation it gave in negotiations with MS, were "wrong." Making this all a little sketchy, but also a lot no-harm-no-foul. Citi was locked into putting a brave face on its MSSB valuation, because admitting that there was a problem would have actually cost shareholders money, in the form of a worse negotiating position with MS. And so Citi provided two separate estimates of MSSB's value, to MS and to Citi's own shareholders, that did not accurately reflect what it thought it would ultimately get for MSSB. And then it didn't. And since everyone pretty much knew that that was going on, no one has much cause to complain. The typical fraud lawsuit starts with "you lied about X, and when you came clean, the stock dropped by $Y, so give us $Y"; here the lawyers' damages would be negative. Citi came clean, as it were, about MSSB, and the market breathed a sigh of relief.

So, I imagine, did Vikram Pandit, though in his case the relief didn't last long. Citi did what probably really was the right thing for shareholders: it maintained with a straight face that MSSB would be cheap at $22 billion. That was wrong, of course, but since no one believed it, it all worked out okay.

2.No really, it really says this. To be fair the second part is phrased as "such disclosure could place Citi at a competitive disadvantage in the event that negotiations with Morgan Stanley regarding fair value were to take place in connection with the exercise of the above-referenced options."

3.Ooooh is that bad? Is it Fraud to tell someone that an asset you own is worth $100X when you value it internally at $80X? No, right? I mean not if your counterparty is Morgan Stanley. Ponder CDO cases however.

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]]>because, why would they?https://www.techdirt.com/comment_rss.php?sid=20130228/15495422160Mon, 22 Dec 2008 21:17:38 PSTInternet Company Valuations Now Below Their Lows From Last Bubble BurstMike Masnickhttps://www.techdirt.com/articles/20081219/0331223175.shtml
https://www.techdirt.com/articles/20081219/0331223175.shtmlthe valuations of 50 or so top internet companies have dipped below their lowest point from when the dot com bubble popped. Of course, in the aggregate, that's rather meaningless. Each of the companies looked at have different circumstances. Besides, the current global financial mess means that no one's really sure how to value anything, meaning that current valuations of pretty much any stock should probably be taken with a huge grain of salt.